Should You Invest in This Market-Maker?

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On Nov. 28, Knight Capital (NYSE: KCG) confirmed that it had received two buyout offers from trading firms Getco Holding Company and Virtu Financial LLC. Both of these private companies have reportedly offered more than $1 billion for the electronic market-maker.

Based in Jersey City, New Jersey, Knight Capital is one of the largest electronic trading firms in the United States. The company specializes in routing orders from retail brokerages and executing them on the New York Stock Exchange and elsewhere. It regularly handles trades for nearly 20,000 stocks and is responsible for routing billions of shares every trading day. For years, it was one of North America's most respected electronic market-makers. 

During the summer of 2012, Knight Capital was found to be responsible for a massive trading disruption that affected the stock prices of dozens of high-volume firms. The glitch forced the cancellation of virtually all of the firm's August 1 trades and caused the company to take a one-day loss of $440 million. For comparison, Knight's total revenue for the second quarter of 2012 was about $290 million. In response to the debacle, its stock dropped by more than 75 percent within the space of a few days. It bottomed out at around $2.25 and had climbed to the $3 range before news of the buyout offers broke.

These two buyout offers differ in several key respects. Virtu looks to take the company private by purchasing all of its outstanding stock for about $3 per share. This would represent a discount of 36 cents to Knight's Dec. 5 closing price. Should they approve Virtu's offer, Knight Capital shareholders will take a haircut of about 11 percent on the basis of the latter valuation. The total value of this all-cash deal would approach $1.1 billion. 

As part of this proposal, all of Knight's existing shareholders would be paid off in cash and Virtu would become its sole owner. It's likely that Virtu would quickly sell Knight's non-core operations as part of the deal and integrate the company's trading platform into its own. Although Virtu's offer is worth at least $300 million less than Getco's, its simplicity and the fact that it's comprised of upfront cash payments may make it attractive to rank-and-file shareholders.

Getco's offer is more complex. Backed by Connecticut-based private equity firm General Atlantic, Getco plans to bolster its already-existing 24 percent stake in Knight with a hybrid deal valued at about $1.4 billion. Under the proposed terms of the deal, Knight would issue 242 million fresh shares of stock and provide exclusive purchase options to current Getco investors. The company would then buy most of Knight's outstanding shares for $3.50 per share. This would represent a 4.1 percent premium to Knight Capital's closing price. 

News of the buyout offers comes at a welcome time for Knight's embattled management team. The company's postponement of a Dec. 3 investor conference suggests that its board is weighing these offers seriously. Board members have stated publicly that each offer will be reviewed in full during the week of Dec. 3. 

Meanwhile, financial mavens and institutional investors appear to see some value in Knight Capital at its current share price. After the August trading disaster, a number of major public and private firms participated in a high-profile bailout of the company. All told, a consortium that included the Blackstone Group (NYSE: BX) and TD Ameritrade purchased a majority stake worth about $400 million. This move underscores Knight's prominence within the financial industry.  Blackstone Group and TD would make a tidy profit if one of these deals went through.

More recently, David Einhorn's Greenlight Capital LLC, made a small, but meaningful investment in the company's stock early in the fourth quarter of 2012. In light of the recent buyout offers, this $15 million investment has already earned a significant return. It's clear that Einhorn believes the company is undervalued in its current condition. He may even anticipate a protracted bidding war that drives its stock price higher.

In the meantime, Knight Capital's shareholders will have to endure a potentially lengthy approval process and a possible bidding war between the company's suitors. In the coming weeks, it's possible that other buyout offers will materialize. Any offer would have to be approved by Knight's board of directors as well as its shareholders. As such, it's unlikely that any deal would close before the end of the first quarter of 2013.


mthiessen has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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